On March 19, 2025, the Appellate Court of Illinois, First Judicial District held that PepsiCo Inc. (“PepsiCo”) subsidiary Frito-Lay North America Inc. (FLNA) did not qualify as an 80/20 company because an FLNA subsidiary set up as the nominal employer of expatriate employees was not the true employer for determining payroll costs. The case is PepsiCo, Inc. v. Illinois Department of Revenue, 2025 IL App (1st) 230913-U.
Illinois’s 80/20 rule allows a unitary business group to exclude a member corporation’s income from combined Illinois income tax returns if 80% or more of the member’s property and payroll is located and generated outside the United States. The Illinois Department of Revenue (“Department”) found that FLNA did not qualify under the 80/20 rule and was improperly excluded, causing about $2.5 billion per year to be added to PepsiCo’s unitary business group income for tax years 2011 through 2013. The Department also assessed $2.1 million in penalties. PepsiCo appealed the Department’s audit findings to the Illinois Independent Tax Tribunal, which ruled in favor of the Department. PepsiCo then sought direct administrative review from the Illinois Appellate Court, which affirmed the Tribunal's decision.
Central to the holding was the finding that FLNA subsidiary PepsiCo Global Mobility, LLC (PGM), the employment company for FLNA expatriates, lacked economic substance and did not establish a sufficient employer-employee relationship with the expatriates to qualify as an 80/20 company. The Tribunal determined that PGM was a shell corporation created primarily for tax avoidance, noting several key factors:
- Control and Supervision: The expatriate employees of PGM were under the control and supervision of foreign host companies, not PGM.
- Compensation and Benefits: The foreign host companies shouldered the costs of the expatriates’ salaries and benefits, and PGM merely acted as a conduit for these payments.
The court emphasized that the most important factor in determining an employer-employee relationship is whether the purported employer has the right to control the manner of an individual’s work. In this case, PGM did not exercise such control, as the expatriates’ day-to-day activities were directed by the foreign host companies and corporate management, not PGM. Accordingly, the expatriates could not be counted as foreign payroll of FLNA to meet the 80/20 test.
The court also highlighted PepsiCo’s failure to seek outside counsel opinions for its tax position. PepsiCo relied on the expertise of its Vice President of State and Local Tax to classify FLNA as an 80/20 company. Despite his expertise, the court noted that his independence and objectivity were questionable simply because he was a member of PepsiCo’s tax department at the time PGM was created and FLNA was classified as an 80/20 company. There was no documentation reflecting any opinion or advice from external law or accounting firms. There was also no evidence of any internal deliberative process or legal research to validate FLNA’s classification.
The case highlights both the need for economic substance to qualify for the 80/20 rule and the need to appropriately document positions that result in the exclusion of significant profits ($2.5 billion annually in this case). This documentation can come in the form of outside opinions from legal or accounting experts, or meaningful internal deliberations and research.
For assistance with tax strategies, planning, and research, including analysis of state and local tax positions, contact one of the Ryan experts listed below today.
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